ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with a financial advisor from Florida dealt with a question on the SECURE 2.0 Act of 2022 (SECURE 2.0). The advisor asked: “What are the changes to the small plan startup tax credits for 2023 and could you walk me through an example, please?”
Highlights of Discussion
First, for businesses with up to 50 employees without a retirement plan that establish a SEP, SIMPLE IRA or 401(k) plan, Section 102 of SECURE 2.0 increases the small plan startup tax credit from 50 percent to 100 percent of eligible costs (capped at $5,000 per year) for the first three years the plan exists. (Prior rules still apply for those with 51-100 employees.) SECURE 2.0 also ensures the startup tax credit is available for employers joining a MEP or PEP, regardless of how long the MEP or PEP has been in existence.
More precisely, the amount of the enhanced credit is 100 percent of the eligible startup costs, up to the greater of $500; or
The lesser of:
- $250 multiplied by the number of nonhighly compensated employees (nonHCEs) who are eligible to participate in the plan; or
Other eligibility rules include:
- The business had at least one plan participant who was a nonHCE; and
- In the three tax years before the first year the business is eligible for the credit, the covered employees were not substantially the same employees who received contributions or accrued benefits in another plan sponsored by the business.
Second, the new law also added an additional credit exclusively for defined contribution plans with 50 or fewer employees. The credit is equal to a percentage of the amount contributed by the employer on behalf of employees, up to a per-employee cap of $1,000. Employees with compensation in excess of $100,000 are excluded from the calculation. This credit applies for five years and is phased out for employers with between 51 and 100 employees.
|Year||% of Contribution up to $1,000|
|1 and 2||100%|
But don’t forget about the third potential plan startup credit that still exists under the old rules. An eligible employer that adds an auto-enrollment feature to its plan can claim a tax credit of $500 per year for a three-year period beginning with the first taxable year the employer includes an auto-enrollment feature.
- Newbie Inc., sets up a new auto-enroll 401(k) plan with a 100% match up to 4% of compensation.
- The company has 19 employees: 17 nonHCEs and 2 HCEs.
- There are eight employees with compensation over $100,000 and 11 employees each with compensation of between $25,000-$100,000, who all defer enough to receive the full matching contribution.
- Total startup costs for Year 1 = $7,500
Credit #1 Startup Credit
Dollar Limitation (The greater of $500 OR the lesser of A or B)
A. $4,250 (i.e., $250 x 17 nonHCE participants)*
*20-50 nonHCEs would impose the $5,000 yearly cap.
Credit #2 Auto Enrollment
Credit for auto enrollment feature = $ 500
Credit #3 Employer Contributions
11 employees with comp < $100K x $1,000= $11,000
|Year 1 Startup Credits|
|100% of costs up to dollar limitation||$4,250|
|Plus credit for auto-enrollment feature||$500|
|Plus credit for employer contribution||$11,000|
|Total Year 1 Credits||$15,750|
Businesses will likely use an updated version of Form 8881, Credit for Small Employer Pension Plan Startup Costs and Auto-Enrollment to claim the credits.
A sweeter tax deal may await small businesses that do not currently offer workplace retirement plans. SECURE 2.0 enhances current plan startup tax credit rules and adds a new tax credit for employer-provided contributions. Plus, the $500 spiff for adding an auto-enroll feature may apply.
Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation.
©2023, Retirement Learning Center, LLC. Used with permission.